WAT - Waters Corporation (WAT) Bank of America Global Healthcare Conference 2023 (Transcript)

2023-09-14 21:02:10 ET

Waters Corporation (WAT)

Bank of America Global Healthcare Conference 2023 Call

September 13, 2023 08:20 AM ET

Company Participants

Udit Batra - President and Chief Executive Officer

Conference Call Participants

Derik De Bruin - Bank of America Merrill Lynch

Presentation

Derik De Bruin

Good afternoon, and welcome to Bank of America’s Global Healthcare Conference Community Live from London. I’m Derik De Bruin, the Senior U.S. Life Sciences and Diagnostics Tools analyst, and it is my pleasure to welcome our next company, which is Waters Corp.

Today with me, we have Dr. Udit Batra, President and CEO of Waters. Welcome Udit, and thanks for making the trip over from Massachusetts. Appreciate it.

Udit Batra

Sure. Thank you, Derik.

Derik De Bruin

To kick things off, anti introductory comments, or shall we start the inquisition?

Udit Batra

You called it the inquisition, so I should make some introductory comments, so that I can delay it. But it’s great to see you, Derik, and great to see every one of you here as well. It’s been three years, slightly over three years since I joined this wonderful company, Waters. And over three years it’s been, right?

Smack in the middle of the pandemic, I joined September 2020, the markets, I guess, Waters are going through some struggles. Markets were struggling. Things went up, supply chain prices, things went down. And now we are struggling through, I guess, a slowing market.

But in all, I think it’s fair to say over the three years, the team that we’ve put together has delivered on what we said. We said we will return to our commercial momentum and we have. It’s got some pretty nice growth and Q2 was no exception.

We’ve recharged our innovations. A lot of stuff was stuck in late stages in our pipeline. We launched it and it’s doing pretty well in the market. And we also said we will start to get more open to other ways of allocating capital beyond share buybacks and we made the largest acquisition-based company, Wyatt. So it’s fair to say things are moving along as we said.

Now that said, I know what’s on your mind, which is, "Hey, what’s going on right now and what’s going on in China, what’s going on in pharma". And we’ll get to talk about that. But I wanted to say, I’m super, super proud of this team to be able to navigate through all the ups and downs and deliver on what we said and Q2 was no exception, right?

I mean we said U.S. and Europe were pretty resilient. And in Q1, and I think we came out in Q2 and showed with the results, if that’s the case. I think the only soft spot, I guess, the only one that we have to be concerned about is China. Perhaps we’ll talk about that for minutes, but thank you. Thank you for giving me the chance to thank my team for the incredible work that they’re doing great.

Question-and-Answer Session

Q - Derik De Bruin

Yes, it’s been a good rebound in the business, certainly since you’ve taken over. So you and I are old. We’ve been around the Life Sciences industry for a while. I turned 60 last week, so I can say that.

So when I look at the tools market today, I see a lot of similarities with the genomics bubble from the early 2000s. At that time – we’ve been covering Waters since 2001. I mean, since that time, you had – you had this – biotech was booming, there were IPOs. You had pharma spending like drunken sailors, you have the NIH budget doublings and good macro tailwinds. And then essentially, you had everything hit the fan in 2001 and things slowed for a number of years.

So again, you saw the market sort of go from double-digit growth down to low single to mid-single digits. But one of the things that really jump started the market again was in the mid 2005-2006 was when China started spending heavily, right? So that’s a very long-winded set of introductions to....

Let’s talk about China because I think it’s the most critical thing and most investors are asking on. So I hit the first question, is this just a cyclical downturn or do you think there’s something more structural or not?

Udit Batra

It’s a fantastic piece of context. And there are several differences from that time to this. I mean I wasn’t in the tools industry at that time. I was in the pharma industry at that time. But that said, there are – I think we should look at the facts, and we have to look at what we are seeing, and I was in China less than two weeks ago. And so I can share with you some of the insights.

I think the major insight is the government wants the biotech and pharma industry to become much more innovative. So if you look at everything that’s happening through that lens in China, it starts to make sense. And I had a chance to visit a whole bunch of customers. I spent time with our reps. I spent so much time with our teams that they couldn’t [explicit] the CEO, right?

So they had to sort of – they had to keep telling me about what was going on. And at the end, the insight is that the government wants people to focus on innovative molecules. And so why do I come to that conclusion? And let’s take the pharma market. I think that’s where your question really is, pharma in China, what’s going on. And it has really three segments, right?

The first one is biotech, right? So the biotech industry in China went up, multiples going in the U.S., even faster. It became 20% of the overall market for asset piece, and in March it crashed.

That said, we’re starting to see it come back to life, not becoming 20% of the market. But there are some – there is some good science going on, and you can follow it and you can see the in-licensing that is going on. Merck is in-licensing compounds from companies in China. So there’s good science going on. So the biotech industry will come back, but probably not to the same levels.

Second is the branded generics market, which is the largest portion of the market. And then over many, many years, this market has sort of been subjected to the VBP, right? And price cuts every year, every couple of years. And right now, it’s no different. But what’s happened in addition is the government has launched the anticorruption campaign.

Now the context behind that is also straightforward to understand, right? The government has said, "Look, we don’t want you to spend a lot of commercial dollars on generics. Everybody should know what generics are, [indiscernible] should able to prescribe without you telling them what it is. And the government has just said, "Look, we don’t want that interaction. We don’t want the reps to go in detail to physicians in hospitals."

So they took 150, 160 hospitals aside and said you guys got to stop and they went to the pharma industry and told them to stop. And everybody is trying to figure out what that means and how they’re going to restructure their commercial forces and I had a chance to talk to our several pharma customers, right?

So they’re trying to understand it. I don’t know how long it takes, couple of months, three months. And if I’m confronted with that as a business leader, I restructure my commercial force fast and then get back on track, right? So I think that’s what they’re going through now. Again, the focus is to move everybody towards innovation, don’t spend money on stuff that is not adding value to innovation.

And then the third part of the market is contract manufacturer, right? And this has grown rapidly over the last few years in China, and that is, of course, hit by the slowdown in biotech, the slowdown in branded generics, but also ex-China customers, right, who sort of pulled back some of their volumes and some of the volumes dissipated after the pandemic as well, right? So that’s the breakdown.

And in the contract manufacturing piece, it’s still going down, right, and the volume is still coming out. Some of it is going to Singapore, the U.S., et cetera, where large contract manufacturers in other sites. And some of it is proportional to the volume that is outsourced from biotech and from the branded generics market.

So if you take all that in context, it’s going to take a little bit longer for us to figure out when the bottom is, right? And I think that’s your question. I’m not courageous enough to predict exactly when that’s happening. I can just give you these factors and say, "Look, it’s all trending in the direction of becoming more innovative."

And I just want to point out one more thing, which is not related to pharma – and you say, "Well, so okay, so it’s becoming innovative, you just said biotech is going to normalize.” Is that where innovation is going to take place? Or is it going to be in the branded generics market? Surely, it’s not in the CDMO market, right?

So where is it going to happen? It’s happening in the academic institutions. I had a chance to visit some universities. Why are they funded? My goodness. I’ve never seen so many instruments, so many high-end instruments in the lab. Electron microscopes, NMRs, high-res mass specs. I mean, stuff that’s super expensive. And with the stimulus, they got even better equipment, right?

So a lot of the basic research is going on in academic institutions, and they are super talented. I mean top researchers are there and good science is going on. It’s a matter of time when they come up with good leads and good molecules. I think where I’m more optimistic is that all of that is now going to get translated into clinical medicines. And that’s where Waters comes in.

And so you say, well, what is the implication for Waters? And it’s a long answer, but it’s something that I wanted to spend time thinking about. What are the implications for Waters? I mean, we are super excited that the country is going to focus more on innovation and it’s going to go towards translational medicine. This is something that plays to our strengths. And that means that we will invest more in technology development in China and not just manufacturing.

Sounds counterintuitive, but I wanted to take you through the story, and it took some time for us as a team and several of us went one after the other. And I went towards the end, and I said, "Okay, so what does this all mean? But I think – I mean, China will rebound. The fundamental demand is there, the population is there, people are going to consume medicines. And what is interesting now is it’s going to become an innovative economy – innovative sector – the biopharma sector is going to become much more innovative. And I think that bodes well for companies like us.

Derik De Bruin

So how much of your business in China is biopharma because there’s also food safety, there’s also chemicals. I mean those – I mean, [indiscernible] markets are?

Udit Batra

60% to 70%.

Derik De Bruin

Okay.

Udit Batra

And academic and government is 11%, 12% growing, of course, rapidly. I don’t expect that to grow like this forever. I mean you know how that segment goes. You give academics money, they spend it and you give them more money they spend it. But I think the top universities are satiated. I mean I don’t know what they’re going to spend on if you give them more because they’re super well equipped. They’re doing research now. The question is when these molecules that they’re developing need to be translated for the clinic, that’s where the spending will go next.

Derik De Bruin

And what about the push for building out more domestic.

Udit Batra

I think it’s real. I think we should not act like it’s not real. It’s been there for a long time, and let’s divide that into two parts. If you look at the consumables segment, right, reagents, antibodies, even single-use bags, my old business, they are local manufacturers.

And the interesting thing that happened over the last two, three years is that the – these consumables were trialed. Earlier, people only wanted branded consumables, branded antibodies, branded bags, et cetera. But now – in the past, there was no – there was no supply, right, during the pandemic. So they have hired the local guys. And in some cases, they’re just as good.

So especially for research use, that transitions happened to a much larger extent. Now you can’t build new instruments in two years, right? So that transition has not occurred. But I’m convinced that there will be a local economy that will build up that will start making some of the instruments that we supply as well.

Now when you talk about buy local, we’ve not heard at all anything that suggests that if we are inclined to support the innovative economy that would be treated any different than the local players. The government leaves it in the hands of the buyer to make a decision, right? And if you’re a researcher and you’re publishing in top journals, you want the top instruments, right?

And that’s the benefit that we have and it’s the same thing that happens in the rest of the world. So it’s going to catch up – the local environment will catch up to the rest of the world. You will have local players as well, but Waters is the Mercedes of the industry.

And so I don’t expect that to be a meaningful impact. And even if it is, some impact. What do you want to do? You want to exit, right? You want to take your market share from 20% to 0% overnight or do you want to go from 20% to 19%, right? So irrespective of the scenario that you build, having a local technology center, a local manufacturing footprint that serves the customers well, collaborates with the top customers there, builds the innovative biopharma sector, I think, is the right direction.

Derik De Bruin

Going on the consumables side. Obviously, the column usage – I mean there are multiple vendors that have been for a long time. Are you seeing more competition on columns?

Udit Batra

I think columns, the challenge – so challenge, I mean, we’ve seen this forever, right? There have been no end columns for generic molecules, simple molecules. But anything that’s complex, I mean, developing new columns is super difficult. It is probably the most difficult part of our portfolio to copy, right? I mean you’re thinking – and we are the only vertically integrated company, right?

So we make our own particles. We synthesize our own particles. We’ll back our own particles and we functionalize our own particle. So we think there, even if there is other type of competition, it plays to our strength, the data we and others who are at the lower end. So I’m – again, I mean, I feel good if innovation is rewarded because that plays to our strength.

Derik De Bruin

Got it. How much has China been a growth driver for the tools market over the last, I don’t know, 5, 10 years with it? Because I think it’s a question on like I agree with you, it will come back. I think it’s a question of timing. But – so this question is like, are we looking at slower markets for ‘20? Is it – and look I don’t think anyone expects the markets to bounce back to 4% or 6% for next year. I don’t think the overall right. It’s not going to bounce back, right, just given the comp?

Udit Batra

China goes and comes back rapidly, right? So we have a scenario that we’ve built when it comes back faster. We have a scenario where it doesn’t. We’re doing our planning now. And there are reasons to believe that if everybody gets their act together on translational work that we just talked about, that could be a pretty nice growth driver.

If the branded generics folks – and that’s why I wanted to take you through the drivers, right? And if you just double click on them, it’s very easy to talk about it, generalities and not come to any conclusion, right? The biotech piece has bottomed out, right? It can’t go any worse, and it’s starting to get – go up.

Second, the branded generics piece, it’s going to take a little bit of time for the companies to figure out what the new commercial structure will be. So that will take a little bit of time. And then the contract manufacturers, they’ve been obliterated in the last six months. right? So probably a little bit more to go.

But I don’t know how long that takes. And does it take three months, six months, nine months, I don’t know, right? But coming to your question on the importance of China for Waters and the tools industry, I can speak to Waters because I have numbers, right? If you just look at it from the last 18 or so years, right, 2004 to 2022, we have data from that. Waters grew roughly 6% over that time. I think you know this – it does in your reports.

Derik De Bruin

For my numbers are, yes. 5.7% is my number organically.

Udit Batra

So – and China grew 16% in that time. So if you just take China out, the rest of the business grew roughly 5%, slightly shy of 5%. The incremental growth from China was 100 basis points. That’s very substantial, right?

Now if you take the last three years, which I can speak about much more intimately and confidently, China grew 9% on a CAGR basis. The rest of the world grew 9%, right? So we are doing – we are growing faster in this time frame, and we’re going faster without China being accretive to go.

Now there’s something else that’s happening. When we speak about Waters, something else that has happened in Waters as the rest of the world has started to contribute. And I think you pointed that out at our last conversation as well, I mean, the U.S. has been growing nicely. Europe has been growing nicely – as nicely as Europe can. And the rest of the world, I mean India has now been growing mid to high teens for – versus last year or two year’s stack, four-year’s stack. U.S. has rebounded nicely.

So I feel the rest of the world is contributing super nicely, right? And if China takes a little bit longer, it’s not the end of the world, and you saw that in Q2. That’s a data point for us, right? I mean, for us, U.S. and Europe grew high single digits in Q2, and China declined mid-teens, right?

Even liquid chromatography, which everybody said, it’s going to be a long cycle, and there were two or three different points of view on how long it takes to rebound that – rebound it. I mean we will also grow single digits with the exception of China. China went 40%, right? So China is an important market. It will remain important for Waters, but we can do well even if China is struggling further. It’s really important to keep that in mind.

Derik De Bruin

Got it. Any – did you benefit significantly from the prior rounds of the stimulus funding? And what are you sort of like hearing from your sources on the ground and when? Because the government is going to have to step in at some point.

Udit Batra

Look, right, the question is how do they step in right? And again, if you play out the thesis that I just talked about earlier, first, there was the stimulus. We benefited. Our academic segment grew like it’s never grown before, 80% and then 30% in Q2, 80% in Q1, by high-res mass specs or LCs. I mean those guys are equipped like anything, right? I mean they have everything that they want. And if they want more, they can have more.

Maybe there’s another stimulus and it probably goes to lower tier universities to equip them. But I think if you play out the thesis that we talked about, if you want to become an innovative pharmaceutical economy, you have to do translational work, right? And I don’t think there is any intention locally of outsourcing all that translational work to the U.S. and to Europe and to other countries.

We want to build the translational piece, right? And that’s where the investment will go. And that’s my guess, right? And I think, again, it benefits us. I’m not sure if there is a small stimulus when it comes, and I’m not sure which universities or which institutions get it. I don’t think it goes directly to branded generics companies. That’s not something that I would expect. There’s a sea of difference between the research that is happening in top-tier academic institutions versus different companies.

Derik De Bruin

And just going back to something I talked and mentioned earlier, what about material sciences, what about food, those markets? I mean, how are they sort of – from a global basis and also from a China-specific basis.

Udit Batra

So I mean, it’s super resilient, right? I mean we’ve seen our industrial segment grow double digits for the first half of the year and stacked also, it’s growing double digits. The drivers are robust, right? I mean the fast testing. It’s a small portion of our overall business.

Things what I heard is [indiscernible] and that portion – the way it’s characterized today, it’s a $200 million market or so, and that’s only for water testing, right? It’s now people wanted to test sewage, people want to test tissue samples, you name it, right? So the number of samples and the types of samples tested are increasing. The number of molecules to be tested is increasing.

The EPA in the U.S. listed 40 molecules that they call PFAS or PFOS and there are another 160. So anything that has fluorinated carbon is PFAS, right? And these things don’t degrade easily. So there is going to be – over the next decade, there’s going to be a lot of remediation work, there’s going to be a lot of testing work.

We feel extremely good about where we are because we have the most sensitive instrument in the industry. And whenever we go head-to-head with competition in a competitive situation, we win because the customers want a sensitive instrument. The EPA is raising the standard they’ve asked for parts per trillion detection, the instrument detects parts per quadrillion in case you’re wondering, that’s 10 to the minus 15, and that’s pretty significant, right? And it’s a pretty significant competitive adventure. So we think there is a significant unmet need in the PFAS segment.

In the Materials segment, which is where our TA business has been doing well, battery testing. And again, here, China plays a significant role, right? Testing batteries for their thermal resilience is something that we support our customers to do. In the U.S., it’s mostly in the characterization – in the U.S. and Europe, it’s mostly in the characterization segment. Whereas in China, the volume of batteries being produced is so high that they want to take it into QC testing, right?

And again, here, we are working with customers in China CATL, Baidu, BYD and the like, and we’re – we feel very good that some of our testing techniques will move into high volume arena. So overall, the industrial – the nature of the industrial segment is changing, right? The drivers are PFAS, the drivers are battery testing.

And I also want to talk about clinical for a second, right? This is something that we talked about. And I think you and I had also spoken a few years ago about this use of mass spec in early disease detection, right? And I mean, we have roughly $200-ish million business for newborn screening, where you need to test multiple analytes and you need to do it fast, right? And they’re present in minute quantities.

And if you take that logic multiplexed multiple analytes in minute quantities, that logic can be applied to other disease areas like endocrinology, like oncology, and that’s where we are developing the value proposition. In fact, again, China is in the lead, right? So just to give you some facts from 2018 to 2020, that clinical business grew roughly 3%.

We separated that business in 2021 from the rest of it and said, okay, we’re going to make an integrated business. And we’re going to give them their own R&D. We’re going to do some extra capital allocation. That business has grown 13% to 15% since then right? So there are clear unmet needs for early disease detection, for minute quantities of many metabolites we’ve seen.

Derik De Bruin

So let’s turn to biopharma and develop biopharma, so we say, we’re U.S. and European. So, you sort of – I mean, Waters sort of stuck out in the quarters like you were talking – you saw some pickup. I think most of the other life science tools companies were down, I guess, first of all, what is going on within the pharma industry in terms of – are they worried about the IRA? Did they overspend or in COVID? Are they budget conscious, I just sort of like what’s going on and can we separate pharma from biotech and sort of like those like here, so big question.

Udit Batra

It’s a good question. And again, we should sort of segment it a little bit, right? And I think that’s where you want to go as well. But the 10,000-foot view is, yes, there are capital constraints. And we have said nothing different. I mean our results have been good because we’ve been talking about it relatively speaking, good because we’ve said, look, some of the spending was delayed from Q1 to Q2, and we saw Q2 pick up, right?

And the decision time is longer. There’s no question about it, right? My old friends who are heads of manufacturing or CEOs or some of these companies that I worked with a while ago, they’re all taking – like my CFO and I do now, right? We stay connected, put an extra step and so guys do you really need this right now. The interest rates are high. Inventories are higher than they were because the demand has gone down, and we need to work on working capital and preserve cash, do you really need to spend this right now, right?

So yes, there is a slowdown in approval. However, there are zero cancellation of orders in U.S., Europe and Asia Pacific, right? We have not seen any cancellation of orders because the quality of orders is very high. People need these instruments, you’re talking CapEx; you need these instruments, they’re just saying, “Hey, can I just delay it a little bit, right?”

So I’ll come to the question of budget flush in a minute, right? And so we believe – is it use it or lose it again? For 20 years, and I asked my colleagues who’ve been in – and you’ve been around for a while. I mean there’s always been a budget flush. So the question in my mind, I mean, intellectually, you say in China, it makes no sense, right? So there will not be a budget flush in China.

Maybe there is a little bit, but – but I think you’ll see different behavior geographically. You’ll see different countries and different companies behave a little bit differently. So it will not be a bolus. But you will see some places where they’re well-funded. I mean the companies that have GLP-1s, the companies that have Alzheimer’s compound. I mean you don’t want to support those molecules, what do you want to do, right? I think I cannot imagine they’re not supporting them, right?

So I think we’re trying to oversimplify when you ask that question. Is there going to be a big budget flush or not. Everybody is going to behave the same, no. I mean everybody’s situation is different. So they’re going to behave a little bit differently. So you’ll see probably a weighted average, probably not as high, but a little bit, but definitely some, right, depending upon which institution you’re talking about. So what’s going on in biopharma, overall, a bit of caution, overall preservation of cash but not universally.

So – and I think that’s important to keep in mind. And that’s why we’ve sort of said it in – we don’t know whether some things in the past. Now separating biotech, biopharma, generics, contract manufacturing, I’d say, those are the four sectors, right? We talked a bit about contract manufacturing. There’s overcapacity in contract manufacturing in biologics, small molecules around the globe.

I think people have gone – people went crazy in putting capacity down even prior to the pandemic, right? So I think there the demand is not going to be as high as it’s been in the past. So let’s put that aside for a minute.

Generics, I see absolutely no change. I think we talked about China, and we don’t need to repeat that. But in India, I see no change. In the U.S. I see no change. The volume of generics is going up, the testing will go up and you’ll need LCs and columns and mass specs to do those experiments.

Now let’s move to biotech, and we talked about China. So we put that aside, biotech in the U.S. that’s the other place where it’s pretty strong, went down pretty dramatically in March, but it’s come back quite nicely, right? I think there were some low-quality companies and compounds being funded. That is all flushed through the system, right, which is good, right?

So now you have bottomed out and it’s starting to go up again nicely and they’re starting to purchase. They’ve not changed their business model dramatically, right? They’re just much more conscious on what they’re spending on.

And then finally, on pharma, we talked about large pharma and not all large pharma created people. So I think that’s – I would – it’s good to look at the different segments. But large pharma is about 25-ish, 25% to 30% of the overall market, not more, right? Biotech is 10%, 12%. Generics is 25-ish percent and the rest is contract manufacturer, right?

So it’s not that you’re completely dependent on – and again, there’s an obsession of trying to oversimplify and say well, large pharma is behaving this way. So everyone’s behaving this way. Not really. Biotech is starting to come back, especially in the U.S. and look at it geographically.

So we have a matrix like this in our company where we sort of have segmented the different markets and the different geographies and there are greens and there are reds, right? China is the red, especially in branded generics, especially in contract manufacturing and the U.S. is green, right? So again, I would not oversimplify it.

Derik De Bruin

You’re talking to a sell-side analyst. That’s what we’re doing. We only have so much bandwidth. So you – I mean, are you hearing anything on – is this just – is this caution as people sort of digest the IRA or just – I guess the question is like when do you expect to see a bigger rebound in the biopharma spend or I’m not going to say the floodgates open. But doesn’t suddenly become – budgets are flowing again. I mean, historically, that’s been a second quarter situation.

But I would agree with you, I mean all of my models assume 4Q is higher than 3Q. I mean I know it’s a flush. It’s just the seasonality that you’re going to have something spending more. But when do we really get that? Okay, it’s 2Q – they know what the IRA is, they know what this thing around and then budgets coming out again.

Udit Batra

I think I mean the IRA is in the discussions. But again, not everywhere, not as predominantly and some companies have rare disease drugs. I mean they’re fine, but it’s difficult to predict, Derik, right? I won’t sit here and tell you, "Hey, this is when the behavior changes. " And it is different by company and geography. It’s very difficult to right now say, "Hey, exactly when the cycle will be shorter again." Exactly when the CapEx crunches imaged.

Derik De Bruin

Yes. I’m getting yelled at by the hedge funds, listening, if I don’t ask you the question of – since you reported the quarter, and today, have you seen any sort of notable changes in the markets?

Udit Batra

[Indiscernible].

Derik De Bruin

I know, but if I don’t ask the question we have a bunch of techs that yellow me for not asking the question. So I guess the – so I think coming up within the context of IRAs like corporate tax rates that you still feel comfortable with where your tax rate is? I mean it’s historically been relatively conservative. I mean it’s already low I should say.

Udit Batra

Nothing new to add.

Derik De Bruin

Okay. You mentioned GLPs and you flagged this on your earnings call. Can you sort of talk about how that sort of impacts your business?

Udit Batra

I think it’s too early to start quantifying it. I think that’s what you asked. It’s too early to start quantifying it. What I can tell you and you can do the volume calculations yourself, right? What I can give you is that our columns are in the lead and they are specified to separate best to the GLP-1s from the two leaders in the industry. Our LCs are the leading LCs for them.

In addition, for the largest one, we have our online and at-line testing equipment business, [Petrol], something that was developed in collaboration with Merck way back shop and [indiscernible] 2000s. And it’s something that’s been adopted. I know that’s now being used. It’s going to be adopted across multiple manufacturing sites.

So we are not yet seeing the volume impact of GLP-1s, right? And the volume has not started to pick up because the multiple manufacturing sites have not started to produce. And so you’ll see that in the coming years. We take this again and again and again with my colleagues, and I said, I said this is based on what you told me, and I also talked to the customers, it’s super clear that our columns and our LCs are the ones that are involved.

Derik De Bruin

Got it. How should we think about your controlling costs, your spending, your current – basically, this is a margin question. Like how do we sort of think about the margin evolution here, particularly in the context that you just added why it, right? And that has – obviously also impacts your margins. So can you just talk about baseline for this year, how do we think about margin expansion going forward?

Udit Batra

I think the basic algorithm is what we’ve talked about in the past, right? We basically said, look, if we grow 5%, there’s about 50 basis points in gross margin that on – and – we’ve also talked about the fact that Waters has really never implemented any of the modern productivity approaches, right? We didn’t implement any Lean Six Sigma across our manufacturing sites. We don’t have a – we didn’t have a capability center. So we were – we had all these vendors who were charging a phenomenon leg to do IT work. So we’ve got in and creating an offshore shared service center.

So all of those initiatives are ongoing, right, and they should add another 50 basis points. But we also said that we want to move our business increasingly towards high-volume testing in faster-growing areas, right? And so small molecule GLP-1s, by the way, are small molecules, right? So much for the theory of only large molecules being great.

But we want to move our business and capture faster growth with the same business model. High-volume testing in compliance-heavy areas, right? And that requires additional investments. We said 22 – sorry, 70 to 80 basis points will go in that direction organically, and we are continuing to invest in that area. And so if you add all that up, you were looking at 20 to 30 basis points of margin expansion every year.

We saw more than that in Q1 and Q2. But I don’t want to promise that we’re going to see 100 basis points every six months. We want to invest. And I think just giving you some proof points on where I have even more confidence in the areas we’ve been, the bioanalytical, take Wyatt in that area, right?

We said that we want to build the world’s leading bioanalytical frame, meaning for large molecules, for mRNAs, for monoclinal antibodies or antibody drug conjugates, the QA, QC units should be similar to small molecules. You should be able to take data and file it with regulators and not have to do bioequivalent studies to show molecule A is equal to molecule B.

In this case, it requires more than one instrument. It requires LC. Where LC is already in the flow, it requires a simple mass spec, requires multi-analyte scattering to get the physics of the molecule and maybe one or two other techniques. But all of that has to go into one compliant software called Empower. Empower is already in the use for LC, it will be used for the others. And so that’s progressing super well.

I mean, in fact, our BioAccord now used for raw material testing and Janssen has already published data. So in Janssen’s published data, you can imagine others are following. Our BioAccord has already used for online and at line testing and tool selection. This is our work with Sartorius and several customers have adopted this. You go downstream, AstraZeneca has taken the BioAccord and started to do at line testing. And for QA/QC Regeneron is in the lead.

So I’m naming these folks because they allowed us to name them, but you can imagine there’s a whole bunch of other customers who feel that it’s time that more sophisticated techniques, simpler versions of those make it into high-volume testing. So they don’t have to do 60 tests and file them in the drug master file. And I feel really good about the problems that’s been made, right? And I want to invest more in that area. And that’s why you won’t see 100 basis points of margin expansion.

Derik De Bruin

Just – I know we’re sort of coming up on time. Any questions from the audience?

Unidentified Analyst

Yes, you touched briefly on Wyatt couple of talks. Can you talk about how that fits into your portfolio and if there’s anything else out there where you see gaps, especially on that bioanalytics side that complement the business.

Udit Batra

There’s always more toys, right? There are always more analytical techniques that we can add. And so I won’t name all of them, but there are a few, maybe one or two that we think we can add to the armament. But Wyatt is going super well, right?

We – just to sort of take a step back, multi-angle light scattering replaces a whole bunch of other techniques, and it’s way simpler to use. It replaces analytical ultracentrifugation, it replaces dynamic light scattering, it replaces PCR testing if you want to look for genomic loads. It replaces a couple of other techniques that look at empty versus full capsids for viral vectors, right?

So multi-angle light scattering has already got a place in characterization of large molecules. And it is a technique that is furthest along in QA/QC when you think of any other technique outside of LC.

So our customers came to us and they had said, "Look, can you guys put this data on to Empower or make it compliant ready?" And we’re very far along that journey. So just to give you an update on what we had committed to on the synergies, right? So we had said, “Look, we will get the Waters field force to get us a lot more needs for multi-angle light scattering instruments.” Despite the slowdown in the market, we still grew to – we still added 200 basis points to our overall growth in Q2 through Wyatt. And it still remains very much on track despite the slowdown, right?

So the lead sharing is going very well, both ways. Second, we had said we will attach our SEC columns to every multi-angle light scattering instrument that sold that we said we’ll do in Q3. It’s already happening, right? We’re already selling. And number three, we had said our HPLCs will replace a competitor’s LC of choice when multi-angle light scattering instruments are put together with LCs and that’s already happening.

So very far ahead of where we thought. And I think were it not for a slowdown in CapEx overall, you would see even a much larger impact already. But the seeding has happened. And it’s a great acquisition and the cultures are very similar between the two companies. So I feel very good about it.

Derik De Bruin

So we’re at the one-minute mark. You know my standard question, my closing question, what’s misunderstood or underappreciated about Waters?

Udit Batra

I think given that it’s an instrument heavy business. I think it’s important for people to realize that instrument heavy businesses will always go, they’ll always fluctuate, right? But if you look at it on a long-term basis, it grows 5% as a 60% gross margin, mostly a replacement business requires next to no SG&A, et cetera business, right?

And now as you go forward, and this is only 50% of our business, the other 50% is growing high single digits, right? And if you go forward now, all the drivers are even better, right? So we’re moving towards faster-growing areas like biologics, like LCMS and diagnostic testing, like battery testing. We’ve got better pricing because we brought in a lot more innovation and our systems and processes are better, right?

So it used to be 50 basis points and that 5% and now we’re seeing in excess of 200 basis points, which we intend to continue, right? So as you look at this and in the high – and then if you look at faster-growing areas, we’ve just talked about characterization of biologics. This hasn’t even moved into QA/QC yet, right?

So this is a really darn good area to be in. And I think if we have the stomach for fluctuations because anytime you have a replacement business, it’s very easy to postpone the replacement one or two quarters. But you have to replace it. That’s why this business closed 5%.

So I think that’s the part where we have to do even more to explain the Waters story and why it is a fantastic business the way it is today itself. And we don’t need to now sort of look at massive restructuring of the business going this way or that. So super happy with the structure of the business. We just need to do even a better job of expanding.

Derik De Bruin

And with that, thank you, Udit, thanks for being here. Thank you, everyone, for listening. Great conference.

Udit Batra

Thank you, Derik.

For further details see:

Waters Corporation (WAT) Bank of America Global Healthcare Conference 2023 (Transcript)